Infratrack

Road to recovery

An India Ratings & Research analysis of the implications of some key governmental measures in the Roads and Highways sector.

The government of India has proposed a slew of measures over the last couple of years to resolve fundamental issues plaguing the ailing roads sector. India Ratings & Research (Ind-Ra) is of the view that these measures are well intended to revive investor sentiments and put the sector back on the growth path. However, the agency does not expect benefit to be realised in the near term as the government has been sporadically attempting to fix issues separately instead of a one-time redressal of all issues. Also, delays in translating announcements into concrete, on-the-ground actions are diluting their efficacy. Moreover, there is no unanimity of thought among various agencies in resolving issues, leading to contradictory positions and sub-optimal solutions. This is what the rating agency has to say on various measures:

On the constitution of a road regulator:

The ratings agency expects the establishment of a roads regulator, as was announced in the Union Budget 2013-2014, only post elections. The risk emanates from the fact that the setting up of the regulator, already delayed, could take time post the conclusion of the forthcoming general elections. The Finance Ministry has raised questions about the structure of the proposed regulatory body. These include whether the proposed regulator should play a dual role of quasi-judicial as well as advisory functions. On the back of numerous challenges facing the sector, Ind-Ra believes that more than the actual setting up of the regulator, determining the contours of a regulatory mechanism will be the challenge. Other areas which could see a speedy resolution include changes in the scope of work and grant of provisional completion certificate so that commencement of tolling is not unreasonably delayed. It would be crucial to see how the regulator manages the potential friction between government and private players in resolving existing risks in the sector.

Impact: Positive

Premium rescheduling continues making headlines:

Primarily due to big-ticket names and the quantum of money involved (around Rs 200 billion), rescheduling or delaying premiums (amount paid to concessioning authority annually) has been grabbing most of the news headlines. On 5 March 2014, the Finance Ministry, in line with the recommendations of the Rangarajan Committee decided to reschedule the premiums of over 30 projects. However, this may not necessarily provide substantial relief to these projects. The decision comes after some players, who had offered astonishingly high premiums, threatened to pull out of the respective projects citing viability issues. The revenue shortfall loans proposed by the committee may not be viable for projects that have fixed revenue share/premium arrangements. If existing contracts are terminated or re-bidding is to happen, it may not be able to attract attractive premiums like before due to the current slowdown. In fact, in sharp contrast, some projects could require viability gap funding from the government.

Continuing with projects in the present form would not be a feasible alternative. This is because they either will not take off or could be headed for default if already commenced or completed construction.

So, restructuring in a manner that makes these projects financially viable is an option, failing which they may even have to be cancelled and bid out as engineering, procurement and construction (EPC) contracts.

Impact: Neutral

NHAI’s shift to cash contracts from Build-Operate-Transfer (BOT) has been lucrative :

National Highways Authority of India, in September 2013, insisted the government to award projects as cash contracts.

This was primarily because of the lacklustre response NHAI had witnessed in awarding projects through the public private partnership (PPP) model. Dwindling developer interest in the PPP model is reflected in the fact that NHAI awarded a paltry 123 km of its 2,000 km PPP target of 2013 as of early November 2013. The relatively better bandwidth of small developers (in terms of bidding) plus the minimal risk of EPC model may make cash contracts lucrative. If implemented, cash contracts could help developers to concentrate on the core business and improve their liquidity.

This could provide a boost to the slowdown-hit infrastructure companies which have not been showing keen interest in bidding under the PPP model.

Impact: Positive

‘Rule of Three’ – Potential cause for low participation :

The rating agency expects more realistic highway project bids in the near future. This is because the Highways Ministry has stipulated that, at any point, a developer should not be allowed to bid for further projects if financial closure for at least three of its projects is pending. This came on the back of aggressive, and more often unrealistic, bidding which had become more frequent at one point in time. Although a few developers have monetised their assets to reduce the current stress on project cash flows, the returns have been below expectations. The strained financial capability of project sponsors cannot be over emphasised at this juncture. Ind-Ra believes that this measure will gain ground if the plans to sell stakes in projects, at the desired valuations, materialise in a timely manner. Else, this could only act as a further impediment to the sector.

Impact: Positive

Partial tolling during construction positive for National Highway projects:

In terms of mitigating revenue risk, national highway projects have an edge over state highway projects since partial tolling is allowed if at least 75 per cent construction is complete and the balance is stuck due to reasons not attributable to the concessionaire. In such a case, the concessionaire is permitted to commence tolling on the completed stretch. The measure has had a positive impact on those projects where any inordinate delay does not hamper implementation schedule. Also, the (partial) revenue generation ability of projects is not hampered by the constraints of the concession grantor. However, toll collection would be only on the completed stretch. Debt amortisation will be based on the entire approved term loan facility, although actual drawdown could be lower than the term loan facility. India Ratings expects this to constrain debt service coverage ratios. The stipulation also helps in reducing funding requirements, either from sponsors or from lenders. It also reduces dependence on the infusion of funds from sponsors and is less likely to impair the project’s ability in timely servicing of debt according to the loan repayment schedule.

Impact: Positive

Land Availability - Condition Precedent before Appointed Date :

The timing of loan disbursals could be more rationalised for projects based on the BOT model. Contractual obligations under the model require around 80 per cent of the land being made available before a project company announces the appointed date – the day from which the concession period starts.

The balance land should be made available within 90 days from the appointed date. This is primarily because concessioning authority has, in numerous cases, not been able to handover land, free of encumbrances, leading to delays in initiating construction which leads to time and cost overruns. In the absence of such a provision, when debt has also been drawn down and huge amounts have been spent but the project fails to take off, restructuring of project loans becomes inevitable.

Impact: Positive

Delinking of Forest from Environment Clearance :

The Supreme Court’s decision to delink forest clearance from environment clearance is likely to benefit highway projects which are stuck due to pending environment clearances. Earlier, even in cases where a small stretch of road passed through a forest area, projects could not commence work though the Environment Ministry’s approval was in place. The order is likely to provide the much-needed impetus to various projects which were stuck due to the linking of these two clearances. A concession grantor could examine projects which have forest stretches and identify the ones which could, pending approvals for that stretch, be deemed as complete. This would ensure that commencement of tolling is not unduly held up and scarce financial resources are not wasted.

Impact: Positive

Relaxation of exit clause for developers :

The relaxation of exit clause is likely to permit new investors with deeper pockets to buyout the rights to develop and operate highway projects from the developers who had bagged them originally. This is with respect to the Ministry of Road Transport and Highways’ (MoRTH) announcement in January 2014 allowing concessionaires to divest their entire stake ‘harmoniously’ in road projects without necessarily forming new SPVs. The need to recognise funding constraints could not have come at a more opportune time. Equity infusion has lately been a major challenge for developers. Hence, the substitution of existing developers (even during the construction stage) would help in the timely completion of projects, which is the need of the hour. Though the move sounds gratifying at the onset, Ind-Ra believes that it would be better suited for projects where commercial operations have begun. This is because a larger problem is land acquisition subsequent to the mandatory handover of 80 per cent of land (by NHAI to private players), required for financial closure. Disagreements related to valuations between new developers and existing players could slow things down. The trading of shares within the same SPV will prevent project companies from incurring new stamp duty and other costs and keep potential tax and depreciation benefits intact.

Impact: Positive

Electronic relief for vehicular movements :

MoRTH is likely to deploy an electronic toll collection system (ETC) for national highway projects on an all-India basis. The system will drastically increase convenience levels with a near non-stop toll collection and create a leak-proof tolling management system for developers. The timeline (end-4QFY14) for the implementation of this system across the country though seems unrealistic. The ETC system would address worsening traffic congestion at various toll plazas and also pave the way for maintaining a central electronic database for potential traffic studies. Though this is a welcome measure for the sector, India Ratings believes that it would work well only for motorists who use highways almost every day. Also, to augment/complement the user experience, one lane on either side would have to be dedicated to the system. This may be a small measure in light of the problems facing the sector at this juncture, however it could definitely make a difference.

Impact: Positive

Revised toll policy to stress financial and liquidity profile:

MoRTH while reviewing the toll policy has notified that fee rates for a section of a four-lane highway shall on and from the commencement of the work relating to upgradation to six laning be 75 per cent of the fee applicable on the date of commencement of the National Highways Fee (Determination of Rates and Collection) Amendment Rules, 2013, till the completion of the project without any annual revision. Further no user fee shall be levied for delayed period. Developers use pre-construction toll collections to fund project equity. Also, they use toll collections to pay negative grants to NHAI even during the construction stage. Ind-Ra believes that the amended policy would add to the financial and liquidity stress of project developers. Also, it is likely to restrain them from responding to BOT-based bids from a concession grantor. The policy amendment envisages a reduction in toll rates by 25%, no allowance of escalation and no levy of user fee during the delayed period. This would necessitate significant additional support from already constrained sponsors.
Ind-Ra does not have clarity if the regulator will allow developers to collect user fee on projects delayed on account of concession grantors due to delays in land acquisition. Penalising developers for land acquisition delays by grantors will adversely impact private investments in the sector.

Impact: Negative

Conclusion

The impact of the proposed measures on the credit profile of project companies would be clear only once they take full shape. Developers are either not investing in or exiting highways projects citing the government’s inability to provide the required clearances in time and thereby making the projects unviable. Following completion of the upcoming Parliamentary elections, the sector is likely to gain renewed attention from policy makers. The government's continuous efforts to improve the funding situation in infrastructure and clear could provide a further fillip to the liquidity-starved highway sector. All stakeholders would definitely hope that these measures will rekindle investor interest and propel it on the growth path once again. At the moment, investments in the infrastructure sector are viewed as risky. While implementing bodies and developers are looking at a course correction, the road to recovery seems some distance away.

Infratrack

Road to recovery

An India Ratings & Research analysis of the implications of some key governmental measures in the Roads and Highways sector.

The government of India has proposed a slew of measures over the last couple of years to resolve fundamental issues plaguing the ailing roads sector. India Ratings & Research (Ind-Ra) is of the view that these measures are well intended to revive investor sentiments and put the sector back on the growth path. However, the agency does not expect benefit to be realised in the near term as the government has been sporadically attempting to fix issues separately instead of a one-time redressal of all issues. Also, delays in translating announcements into concrete, on-the-ground actions are diluting their efficacy. Moreover, there is no unanimity of thought among various agencies in resolving issues, leading to contradictory positions and sub-optimal solutions. This is what the rating agency has to say on various measures:

On the constitution of a road regulator:

The ratings agency expects the establishment of a roads regulator, as was announced in the Union Budget 2013-2014, only post elections. The risk emanates from the fact that the setting up of the regulator, already delayed, could take time post the conclusion of the forthcoming general elections. The Finance Ministry has raised questions about the structure of the proposed regulatory body. These include whether the proposed regulator should play a dual role of quasi-judicial as well as advisory functions. On the back of numerous challenges facing the sector, Ind-Ra believes that more than the actual setting up of the regulator, determining the contours of a regulatory mechanism will be the challenge. Other areas which could see a speedy resolution include changes in the scope of work and grant of provisional completion certificate so that commencement of tolling is not unreasonably delayed. It would be crucial to see how the regulator manages the potential friction between government and private players in resolving existing risks in the sector.

Impact: Positive

Premium rescheduling continues making headlines:

Primarily due to big-ticket names and the quantum of money involved (around Rs 200 billion), rescheduling or delaying premiums (amount paid to concessioning authority annually) has been grabbing most of the news headlines. On 5 March 2014, the Finance Ministry, in line with the recommendations of the Rangarajan Committee decided to reschedule the premiums of over 30 projects. However, this may not necessarily provide substantial relief to these projects. The decision comes after some players, who had offered astonishingly high premiums, threatened to pull out of the respective projects citing viability issues. The revenue shortfall loans proposed by the committee may not be viable for projects that have fixed revenue share/premium arrangements. If existing contracts are terminated or re-bidding is to happen, it may not be able to attract attractive premiums like before due to the current slowdown. In fact, in sharp contrast, some projects could require viability gap funding from the government.

Continuing with projects in the present form would not be a feasible alternative. This is because they either will not take off or could be headed for default if already commenced or completed construction.

So, restructuring in a manner that makes these projects financially viable is an option, failing which they may even have to be cancelled and bid out as engineering, procurement and construction (EPC) contracts.

Impact: Neutral

NHAI’s shift to cash contracts from Build-Operate-Transfer (BOT) has been lucrative :

National Highways Authority of India, in September 2013, insisted the government to award projects as cash contracts.

This was primarily because of the lacklustre response NHAI had witnessed in awarding projects through the public private partnership (PPP) model. Dwindling developer interest in the PPP model is reflected in the fact that NHAI awarded a paltry 123 km of its 2,000 km PPP target of 2013 as of early November 2013. The relatively better bandwidth of small developers (in terms of bidding) plus the minimal risk of EPC model may make cash contracts lucrative. If implemented, cash contracts could help developers to concentrate on the core business and improve their liquidity.

This could provide a boost to the slowdown-hit infrastructure companies which have not been showing keen interest in bidding under the PPP model.

Impact: Positive

‘Rule of Three’ – Potential cause for low participation :

The rating agency expects more realistic highway project bids in the near future. This is because the Highways Ministry has stipulated that, at any point, a developer should not be allowed to bid for further projects if financial closure for at least three of its projects is pending. This came on the back of aggressive, and more often unrealistic, bidding which had become more frequent at one point in time. Although a few developers have monetised their assets to reduce the current stress on project cash flows, the returns have been below expectations. The strained financial capability of project sponsors cannot be over emphasised at this juncture. Ind-Ra believes that this measure will gain ground if the plans to sell stakes in projects, at the desired valuations, materialise in a timely manner. Else, this could only act as a further impediment to the sector.

Impact: Positive

Partial tolling during construction positive for National Highway projects:

In terms of mitigating revenue risk, national highway projects have an edge over state highway projects since partial tolling is allowed if at least 75 per cent construction is complete and the balance is stuck due to reasons not attributable to the concessionaire. In such a case, the concessionaire is permitted to commence tolling on the completed stretch. The measure has had a positive impact on those projects where any inordinate delay does not hamper implementation schedule. Also, the (partial) revenue generation ability of projects is not hampered by the constraints of the concession grantor. However, toll collection would be only on the completed stretch. Debt amortisation will be based on the entire approved term loan facility, although actual drawdown could be lower than the term loan facility. India Ratings expects this to constrain debt service coverage ratios. The stipulation also helps in reducing funding requirements, either from sponsors or from lenders. It also reduces dependence on the infusion of funds from sponsors and is less likely to impair the project’s ability in timely servicing of debt according to the loan repayment schedule.

Impact: Positive

Land Availability - Condition Precedent before Appointed Date :

The timing of loan disbursals could be more rationalised for projects based on the BOT model. Contractual obligations under the model require around 80 per cent of the land being made available before a project company announces the appointed date – the day from which the concession period starts.

The balance land should be made available within 90 days from the appointed date. This is primarily because concessioning authority has, in numerous cases, not been able to handover land, free of encumbrances, leading to delays in initiating construction which leads to time and cost overruns. In the absence of such a provision, when debt has also been drawn down and huge amounts have been spent but the project fails to take off, restructuring of project loans becomes inevitable.

Impact: Positive

Delinking of Forest from Environment Clearance :

The Supreme Court’s decision to delink forest clearance from environment clearance is likely to benefit highway projects which are stuck due to pending environment clearances. Earlier, even in cases where a small stretch of road passed through a forest area, projects could not commence work though the Environment Ministry’s approval was in place. The order is likely to provide the much-needed impetus to various projects which were stuck due to the linking of these two clearances. A concession grantor could examine projects which have forest stretches and identify the ones which could, pending approvals for that stretch, be deemed as complete. This would ensure that commencement of tolling is not unduly held up and scarce financial resources are not wasted.

Impact: Positive

Relaxation of exit clause for developers :

The relaxation of exit clause is likely to permit new investors with deeper pockets to buyout the rights to develop and operate highway projects from the developers who had bagged them originally. This is with respect to the Ministry of Road Transport and Highways’ (MoRTH) announcement in January 2014 allowing concessionaires to divest their entire stake ‘harmoniously’ in road projects without necessarily forming new SPVs. The need to recognise funding constraints could not have come at a more opportune time. Equity infusion has lately been a major challenge for developers. Hence, the substitution of existing developers (even during the construction stage) would help in the timely completion of projects, which is the need of the hour. Though the move sounds gratifying at the onset, Ind-Ra believes that it would be better suited for projects where commercial operations have begun. This is because a larger problem is land acquisition subsequent to the mandatory handover of 80 per cent of land (by NHAI to private players), required for financial closure. Disagreements related to valuations between new developers and existing players could slow things down. The trading of shares within the same SPV will prevent project companies from incurring new stamp duty and other costs and keep potential tax and depreciation benefits intact.

Impact: Positive

Electronic relief for vehicular movements :

MoRTH is likely to deploy an electronic toll collection system (ETC) for national highway projects on an all-India basis. The system will drastically increase convenience levels with a near non-stop toll collection and create a leak-proof tolling management system for developers. The timeline (end-4QFY14) for the implementation of this system across the country though seems unrealistic. The ETC system would address worsening traffic congestion at various toll plazas and also pave the way for maintaining a central electronic database for potential traffic studies. Though this is a welcome measure for the sector, India Ratings believes that it would work well only for motorists who use highways almost every day. Also, to augment/complement the user experience, one lane on either side would have to be dedicated to the system. This may be a small measure in light of the problems facing the sector at this juncture, however it could definitely make a difference.

Impact: Positive

Revised toll policy to stress financial and liquidity profile:

MoRTH while reviewing the toll policy has notified that fee rates for a section of a four-lane highway shall on and from the commencement of the work relating to upgradation to six laning be 75 per cent of the fee applicable on the date of commencement of the National Highways Fee (Determination of Rates and Collection) Amendment Rules, 2013, till the completion of the project without any annual revision. Further no user fee shall be levied for delayed period. Developers use pre-construction toll collections to fund project equity. Also, they use toll collections to pay negative grants to NHAI even during the construction stage. Ind-Ra believes that the amended policy would add to the financial and liquidity stress of project developers. Also, it is likely to restrain them from responding to BOT-based bids from a concession grantor. The policy amendment envisages a reduction in toll rates by 25%, no allowance of escalation and no levy of user fee during the delayed period. This would necessitate significant additional support from already constrained sponsors.
Ind-Ra does not have clarity if the regulator will allow developers to collect user fee on projects delayed on account of concession grantors due to delays in land acquisition. Penalising developers for land acquisition delays by grantors will adversely impact private investments in the sector.

Impact: Negative

Conclusion

The impact of the proposed measures on the credit profile of project companies would be clear only once they take full shape. Developers are either not investing in or exiting highways projects citing the government’s inability to provide the required clearances in time and thereby making the projects unviable. Following completion of the upcoming Parliamentary elections, the sector is likely to gain renewed attention from policy makers. The government's continuous efforts to improve the funding situation in infrastructure and clear could provide a further fillip to the liquidity-starved highway sector. All stakeholders would definitely hope that these measures will rekindle investor interest and propel it on the growth path once again. At the moment, investments in the infrastructure sector are viewed as risky. While implementing bodies and developers are looking at a course correction, the road to recovery seems some distance away.